Jul

13

So, corn and wheat are going up, just about all other commodities, gold included, is headed down. Copper, too? Jury's out. Stocks don't look so hot–valuations are high and guidance is turning pretty crappy. Oh, and there's an election in the offing. So, with the 10 yr Treasury south of 2% (and maybe setting another low in the next several days), where does one put one's money–in Europe?(!?) In…

Tim Melvin writes:

Every time I think if passing on the mess that is Europe I think if John Templeton's advice to invest at the point of maximum pessimism.

Of course all of us have found a supposed max to be a min to our dismay.

I have a baby toe in Europe at this point.

Andre Clapp writes:

My point exactly… Pessimism on Europe, if not at a maximum, is certainly very high. Significant career risk for professionals. Everyone knows you'd have to be an idiot to invest in Europe. Reminds me of the US market during March of '03 and '09. Buffett out today saying Euro is "doomed to failure" with one small caveat. (Who is more front page than the Oracle?) Reminds me of the Economist issue "Drowning in Oil", when oil was $12 a barrel. They felt that oil should trade at $5 a barrel, with one small caveat, "in the absence of political considerations"… Hmmm, seems like a pretty big caveat to me! Needless to say, oil (Brent) trading at triple digit levels only a decade later, even in a weak global economy. The lesson to me: Mind the caveat!

Lastly, The Oracle may have his own personal reasons for "encouraging" the Europeans. He is not above that, IMO. People stating the consensus opinion often leave this kind of trap-door caveat behind. My guess is that the sun will still rise, and Europe will still be here, 10 years from now.

Jun

23

The works of Charles Darwin and Adam Smith are often compared. My wife the high-school science teacher has informed me that despite the descriptor "Darwinian" often being attached to economic or capitalist ideas (Darwinian capitalism, Darwinian economics), rather it was Darwin who got his ideas for Evolution from Adam Smith. Hence we should really say "Smithian" in reference to Evolution, rather than Darwinian in reference to Economics. Nevertheless, that is the way the language has evolved. In the world of Nature or Evolution, the incentive structure is that of "jungle capitalism". That is where the term originates, I believe.

That being said, I don't find the line between "jungle capitalism" and what most of us believe in, which for contrast is often referred to as "rule-of-law capitalism" to always be that clear-cut or well defined! Well known Capitalists (e.g Gupta) often cross the line into jungle capitalism, and vice versa (refer to the "Godfather" movies where the mafia goes "legit" in Las Vegas, but still using violence and their ill-gotten capital to do so.) Other historical examples: union-busting by Andrew Carnegie and grey areas: anti-monopoly laws (a subject for the courts), "Bundling" by Microsoft (a subject for the courts), and most recently "too big to fail".

To my mind, too-big-to-fail clearly crosses the line into jungle capitalism. Here a company does not have to follow the same rules, or face the same risk profile of smaller competitors, simply because of their size. Granted there was presumably some merit involved in attaining this size, but once it has been attained the same merit is no longer required to maintain it. I like the idea of the Beekeeper! Perhaps we as a society should put legal incentives in place that incentivize large corporations to "swarm" once they reach a certain size. (Spin-offs, de-megers are obvious ways of doing this.) Although the benefits of size are well-known (and espoused by Jamie Dimon, was it?) the benefits of diversity are also fairly obvious (for ex, the honeybee, which has been around for roughly 100 million years). I am also a beekeeper, BTW.

Best Regards from vacation,

balloon boy

Jun

21

In a recent trip to the Netherlands, I noted the weakness in the Dutch real estate market. This brought back a memory of a speech by Alan Greenspan in Cambridge, referencing a PhD thesis, that a loss on the value of one's home (nest egg) had twice the impact on consumer spending as an equal loss in the stock market (risk capital). According to Behavioral finance, "errors" like this are a natural tendency of people, and hence persist (are not averaged out) by Mr. Market. In principle, a shrewd investor can take advantage of these market inefficiencies.

The problems with Dutch real estate, similar problems in Denmark, not to mention Spain, do not bode well for European consumer behavior to my mind, possibly for years to come. Does anyone have any thoughts or data on this?

Secondly, my hypothesis regarding the origins of the real estate problems in the US (also possibly Europe, Japan?) has to do with the "baby boom", (the overreaction to the loss of good men in WWII.) One definition of the baby "bubble" are people born between 1946 and 1964 (average 1955), which makes the average baby boomers roughly 57 today. My hypothesis goes like this: as the baby boomers retire, or approach retirement, they shed risk assets or assets they are overleveraged. In this case real estate. As this process ends or mitigates, the real estate market should improve, with dramatic consequences for US consumer behavior. (not tremendously original, I know.)

My question in this: Does anyone have any data on the demographics of people shedding assists, particularly real estate, related to retirement? That is, a graph hopefully showing the peak of asset shedding by people in their 50's and 60's?

Thanks in advance for your thoughts, criticisms, or data,

-balloon-boy

Andrei Kotlov writes:

Andre,

Two quick remarks (but no data) :

(1) Curtailed consumer spending is good for the economy (current consumption destroys capital; production is [mostly] in anticipation of future consumption).

(2) The U.S. housing bubble was caused by the easy-money policy of the Fed; rather, that policy ensured that *a* bubble would appear; other factors (e.g., acts of Congress) directed the easy money into the housing specifically. What you describe (shedding of real estate by the baby boomers) could explain the *burst* of the bubble—though, in my opinion, the burst occurred primarily because the Fed [temporarily] reversed its easy-money policy.

Cheers,

Andrei

Jack Tierney writes:

I don't know that your hypotheses will hold up. I agree that Boomers, and more significantly, their parents, will want to shed assets - including homes and equities. I believe Boomers, like current retirees will find it easy to sell their homes (or condos) IF they're willing to take a significant haircut. Despite what real estate cheerleaders might claim, there's no getting around the facts (from the Fed) that between '07 and '10 the average American household experienced a 39% decline in net worth. The following two years have seen no improvement. Traditionally, those most likely (and financially equipped) to purchase a single family home are college-educated professionals. Unlike those of other past generations, these will be populated by graduates who carry significant amounts of debt - and their creditor is the most relentless, and unforgiving, collector imaginable - the Federal government. Since these debts cannot be negotiated down, expunged by death, or bankrupted away, they will be paid down before capital accumulation can begin. As a result, the cohort most likely to support a resurgent real estate market will be, at best, delayed in bringing it about. Even then, there is and will continue to be a contraction in wages. Significantly, the post-Boomer generations (Gen-Xers and Millenials) will be, relatively speaking, financial beggars. We must remember that the technological advances we can't stop raving about came about as all business advances do - to reduce the cost of production…and wages are (or used to be) a big cost of production. Those few who have been able to overcome the "math is difficult" meme and obtain an education (and degree) in a handful of specialty fields will continue to do well…and will become home owners assuming they have also learned to save…a problematic assumption.

Another cohort, which will include a significant number of college grads, will fight for positions that offer something a little better than above average incomes…they may become home owners but their zip codes, like mine, will not be noted for country clubs, cotillions, or Chris Crafts. A similar cohort, but one slightly less fortunate and/or ambitious, will contain a fair representation of graduates from every level, and their lives will be marked by a payday-to-payday narrative. Some in this group will never repay their education loans and either move in with family members or migrate from one transient hotel to another. They will not contribute to a real estate boom or consumer spending. The final group will be composed of the poor - working and otherwise. I have no idea how big it will be, but am sure it will be substantial, it will be urban, and it will be restless. Public housing will be the order of the day but among its residents there will be those who recall the "good old days" when various government sponsored programs were numerous and sufficient. Some will recall the wealth that existed, how quickly and inexplicably it disappeared, and the culprits (real and imagined) who destroyed it. The primary concern of the government, whatever form it may have taken, will be, as it ever is, to maintain docility.

While these developments might well result in "dramatic consequences for US consumer behavior," I doubt we'll ever see a housing market or the level of consumerism like that we experienced following WW II. It not only requires great wealth, but a great concentration of wealth. The kind that exists only when your major competitors have destroyed their manufacturing bases not once, but twice, in three decades - and yours remains unscathed. Under those circumstance you can build homes or automobiles with varying degrees of quality, pay substantial wages, and still have an incredible boom.

Andre Clapp responds:

Hi Jack,

Alas, I think I agree with you. Looks like we're in for some tough sledding for at least another decade, maybe longer. Not to sound too much like the writer of "Generation X", but I think that the argument can be made that this older generation (including me) has very much "borrowed" or "stolen" from the younger generation. (Pay as you go SS might be an example of this. The high cost of healthcare, the national debt, etc.)

In this sense, I am somewhat sympathetic (often unpopular in financial circles) to the inflationary monetary policies of the Fed and the ECB. Although I agree that printing all this money amounts to "confiscation" of wealth from Savers and bond holders, I think it may be morally justifiable as a politically feasible way to transfer wealth from the older to the younger generations. At least give the younger generation some motivation to work, invest, and take some risk, as opposed to moving in with their parents/grandparents and playing video games all day. I believe we have seen the later in Japan, which to my mind decided to let deflation run its course (and protect the savers and bond holders, which of course are predominantly the older generation.)

What do you think of this?

Also, it is notable that despite the trillions of dollars that have been injected into western economies by the Fed and ECB, it has yet to produce meaningful inflation… Any thoughts on this? Is the psychological impact so great that no amount of monetary easing will produce inflation? Can't push on a string kind of thing?

I couldn't help noticing that the Danish government recently sold bonds at a negative yield.

Best Regards,

-Andre

Andrei Kotlov writes:

Andre,

Two quick thoughts:

(1) Inflation (money printing) amounts to enriching those who stands by the printing press (the gov't) and confiscation from those who are removed from the printing press, in proportion to their distance. The savers (the older gen) will suffer just as much as the future lenders (the younger gen) who will pay the higher rates.

(2) Money printing has not lead to 'meaningful inflation' *yet* because it has been done concurrently with the naturally-occurring deflation (caused by the contraction of credit).

Gary Rogan writes:

To advocate as "morally justifiable" the despicable activity aiming "to transfer wealth from the older to the younger generations" is itself not morally justifiable, regardless of how much the younger generation is expected to benefit.

Also another reason why this activity hasn't resulted in inflation yet is because the Fed is paying banks significantly higher than the market rate to keep their excess reserves on deposit there. Sooner or later this music will stop, and there will be a flood of inflation that will be declared "unexpected" for months on end, just like the number of unemployment claims has been.

Russ Sears writes:

The meal for a life-time I believe is in the anatomy of a bubble contained in the home ownership percentages.

Ownership rate in the US was 63.9% in 1990 with the magic of Mortgage Backed Securities, the Fannie and Freddie programs this was raised to 67.4% by 2000. Then came the push into sub-prime and this was raised to 69.0% by 2004… It hoovered at this unsustainable level a couple years where the greater fool seemed to take over before the dam broke in 2007 with a drop of 0.7% (68.8%/2006 to 68.1%/2007) and the QE fix was in to keep it from continuing the crash and clearing the market. The home ownership in 2010 still stood at 66.9% off 0.5% from 2009. I suspect your conclusions are correct that with the lose of government subsidized financing the ownership rates need to get back to closer to 1990 levels.

However, looking at the numbers it would appear that the older ages have continued to value home ownership.. Those aged 65+ followed a similar path of the overall demographic until recently. (76.3%/1990; 80.4%/2000; 81.1%/2004
80.9%/2006)

With the lower rates they appear to be the ones that currently are taking advantage of them to purchase housing. going from 80.1% in 2008 to 80.5% /2009 and 2010)

This group may very well continue to drop below to the 1990 levels once the rates are not being stimulated.

However, as an actuary well aware of the risk of out living your wealth, I would argue that the home ownership is many elderly household's main hedge against long term inflation. Plus the nostalgia of setting roots and maintaining an inheritance. They would need to be clearly convinced deflation is here to stay before they give up on home ownership.

Gary Rogan writes:

Andre, I'm not sure which intergenerational theft mechanism you mean (one could argue that say Social Security is some for of that type of theft or whatever), but regardless:

Just talking about returning wealth to its rightful owner is communist rhetoric and implies collective punishment for a class of people. There is no justice in making a group of people pay for something they didn't individually undertake. There is no justice in making members of this group pay out of any proportion to how much each of them supposedly "stole". There is no justice in an unelected and unappointed (for this purpose) body extracting this retribution, especially without even a semblance of due process. There is no justice in this body using a totally spurious explanation because it's politically convenient for undertaking this sort of justice.

Of course as a practical matter, this is just theft in order to make the constituent banks whole and to impose taxation by more palatable means mainly to support those in power staying in power. Nobody has any intention helping the younger generation. But to me, justifying collective theft as collective punishment or justice is simply abhorrent.